The “Price” Is Wrong… Unless It’s Not
Robert J. Brown
Certified Financial PlannerTM
Investment Management, LLC
This month’s edition was intended to be on tax issues and your chances of being audited, but I’ll table that for a future topic. My reason for changing direction abruptly comes as I am writing this and watching natural gas having its worst trading day in 9 months and at its lowest price in 2 years. At this moment in time, it has dropped about 6% just today but even more eye-opening, it has been literally cut in half over the last 7 months!
Can this continue? The funny thing about trends is that while you’re seeing one, it seems improbable that things could ever tip the other way. As a very pertinent example, I’ll offer up this excerpt which was published in 2006 by the US Government Accountability Office1:
In early December 2005, wholesale natural gas prices topped $15 per million BTUs, more than double the prices seen last summer and seven times the prices common during the 1990s. For the 2005-2006 heating season, the U.S. Energy Information Administration predicts that residences heating with gas will pay 35 percent more, on average, than they paid last winter.
Wow, how things have changed. I can remember, just a few years ago, back in 2008, when that unit price of gas was up over $11… now it lingers, beaten up under $3. Why is that? What happened? What does that mean for you? That last one may be the most important question for you to ask. Let’s start with the ‘why’.
Supply vs. Demand
It almost always comes down to this model, doesn’t it? That GAO study, done about six years ago, summarizes that during that time our country was seeing an increasing demand for natural gas but a limited supply of it. It goes further to suggest that this can be solved by enhancing our country’s very underdeveloped infrastructure and finding new gas fields, as the current ones (at that time) were old and depleting quickly. Well… mission accomplished… it only took several years to see that happen.
Drilling is all around us now. In 2008, I was driving to various corners of NEPA to see the first drilling rigs (as if spotting a rig was equal to spotting Big Foot) and talk to the crews & foremen. Now, as I drive back and forth to work, I glance at the rigs, casually, like I would a deer standing out in a field. It goes without saying that the gas companies have positioned themselves for the long haul by dropping wells, not only in NEPA, but all across this country. And not just for gas, but for oil and other forms of energy. Technology has changed the game and now this drilling is far more productive than was ever imagined 10 years ago.
Infrastructure has been booming in its development as we see new pipelines in NEPA cropping up each week; linking all of these new wells to their respective distribution hubs. There have been several recent news releases announcing the completion of several major connections which will dramatically increase companies’ abilities to get this gas out to market.
Better or Worse?
In our office, we’ve seen many landowners with a wide variety of experiences. Initial checks are very large and impressive, but the following months drop off in value; sometimes dramatically. Others have had a steady gain in their royalties each month, despite the recent drops in gas prices. Yet still, others have been placed in a production unit but are only seeing a small amount of revenue. Each story is different but the common consensus among them is that once the pipelines are connected, it’s off to the races. Is it? Let’s not count our chickens before they’re hatched.
The missing ingredient to finding price stability and even price appreciation is not in the completion of stronger distribution channels.
Increased Demand is the Key
The much more obvious method of alleviating this inequity is to balance out the scale on the demand side. How do you do that? Can you make the winter colder? That would be a start, but aside from being impossible to do, it would only help the pricing in the very short term. What about the longer term solutions?
Natural Gas is gobbled up in various ways; such as generation of electricity, residential/commercial heating and cooling, and transportation. Each of these has many factors that feed into the ultimate usage of gas but one thing is certain; to date, the increase in demand, although trending toward growth, is just not keeping pace with the massive increases in supply. Simply seeing a drop in temperatures (heating) or a scorcher of a summer (cooling) will not move the dial on pricing too much over time. Long term pricing trends are often more likely affected by changes in the mindset of the consumers, (a willingness to switch fuel sources) in the policies set by our politicians and in the technological advances which provide opportunities to use the gas. (CNG powered vehicles and distribution stations) Until we see such advancements, we may need to get used to the price of natural gas floating near the bottom of its longer term range.
To the Point
It’s important to recognize YOUR role in all of this. You can pick up the flag and push for the causes that you believe in, but you don’t need me to tell you that. I’m talking more along the lines of your relationship with the energy company you have partnered with when you leased your acreage.
It’s important to recognize that each company is different; different how they treat the landowners, different how they deal with their subcontractors, the regulators and the community. As a large company, they are focused not only on 2012, but many years to follow. They have unique financial and economic issues they are facing and thus each landowner will have a unique experience. Their interests may not align with yours. For example, they may prefer to keep the gas contained and very limited in what they bring to the market due to the pricing pressures currently… you may need the cash flow today.
If you take one thing away from this article, please understand that it is virtually impossible for you to predict what your royalties will be in the future. Focus on what IS real… and that’s what is in your check each month. Once it’s in your hand, YOU have full control. Make wise, informed decisions.
Robert J. Brown, CFP®
Direct Link: http://www.gao.gov/new.items/d06420t.pdf